1 The Financial Crisis and its Impact on Latin America LASA Workshop on the Crisis and its Impact on Latin America October 6, 2010 Nora Lustig Samuel Z. Stone Professor of Latin American Economics Tulane University

2

3 1. What was the economic performance of the region before the financial crisis? 2. Where does Latin America stand today and where is it headed? 3. How will the crisis affect living standards?

4 1.Economic Growth in LA Before the Crisis was Robust: 5.3 % a yr (Source: CEPAL)

5 Economic Growth in LA Before the Crisis was Robust

6 2. What were the expectations and what happened?  Two Phases of Financial Crisis (Izquierdo and Talvi, 2008) First Phase: mid-2007 until mid-2008 Second Phase: mid-2008 until ….

7 Phase 1 (cont.)  Conventional wisdom in early 2008: Latin America is in a much better position to withstand the external shock: prudent fiscal policy, sound banking system, low indebtedness and large amounts of international reserves.  Problem: Growth was highly linked to the boom in commodity prices and part of this boom was the result of the policies pursued to tackle with the financial crisis. In particular, with lower interest rates in the US.

8 Phase 2: From mid-2008 Onwards  Realization that: Financial system in advanced countries facing solvency issues Advanced countries in deeper recession than anticipated Emerging economies would face growth slow down. No decoupling Post-Lehman collapse led to global credit market freeze  As a result: Massive redemptions Flight to quality Demand for dollar/US Treasuries sky-rocket => commodity price, foreign currencies, foreign stock markets simultaneously fell =>dollar appreciated

9 Phase 2: From mid-2008 onwards: Biggest fears:  Deep and protracted global recession  Deflation  For LAC: Adverse external shocks for commodity exporters but also for economies relying on exports to US, remittances, tourism and external capital flows (Sources: IMF; Izquierdo and Talvi, Nov. 2008)

10 Boom and Bust of Commodity Prices

11

12 Latin America and the Caribbean: Transmission Channels  Financial: Exchange rate volatility, private sector debt and risky financial investments (Brazil, México) Lower access to international credit markets Capital outflows  Real economy: Lower exports, remittances and tourism Lower commodity prices: bad news for Mexico and South America; good news for CA and Caribbean, but insufficient to compensate for other negative factors

13 3. Where does Latin America stand today and where is it headed?  Growth for 2009 was negative but not as bad as some anticipated.  Countries most affected not necessarily those people were expecting Argentina and Venezuela have been holding their ground while… …Mexico has been hit hard because of its close ties with US economy through exports and capital flows.

LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries represent 91% of Latin America’s GDP. LAC-7 Central America (Real GDP, annual variation) -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% * 4.8% -1.9% Russian Crisis Beginning of the Boom Lehman’s Bankruptcy -1% 0% 1% 2% 3% 4% 5% 6% 7% * Russian Crisis Beginning of the Boom 4.4% -0.6% Real Impact of the Global Crisis: Economic Activity CAC-7 is the simple average of Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic, Nicaragua and Panama. * Estimate. Source: JPMorgan and WEO (CAC-7) Lehman’s Bankruptcy

15

16 LAC Currencies: Appreciation Followed by Sharp Depreciation

17 US-Mexico correlation of business cycle in manufacturing sector

18  For the first time in decades, Latin American economies got hurt mainly due to adverse external shocks and not because of poor domestic macroeconomic policies.  Adverse external shocks are also an impediment to implement counter- cyclical fiscal policies. => Adjustment costs can be significant

19

20

21

22

23

24

25

26

27

28

29

30

31 4. The Impact of the Crisis on Living Standards  Unemployment  Real Wages  Remittances  Government monetary and in-kind transfers  Poverty (tbc)  Inequality (tbc)  Other social indicators (tbc)

32

33

34 Are Countries Ready to Mitigate the Impact on the Poor?  Which countries introduced counter- cyclical safety nets and what kind?  Did they cover the universe of the affected population?  Were transfers sufficiently large to compensate for the income losses?

35 Conditional Cash Transfers in LAC (Source: Inter-American Development Bank, 2008) Without programPilotSmall scale (<25% poor) Medium & large scale (>25% poor) Bahamas Haiti Barbados Nicaragua Belize Suriname Guyana GuatemalaCosta Rica El Salvador Dominican Rep. Honduras México Uruguay ParaguayJamaica Panama Bolivia Trinidad y Tobago Venezuela Argentina Perú Brasil Colombia Chile Ecuador 11258

36 THANK YOU